This Factsheet briefly discusses some of the main issues relating to security and risk and how these can have an effect upon your pension benefits.

It is written for people with a pension benefit currently in payment from a defined benefit scheme irrespective of whether your benefits started being paid at Normal Retirement Age or paid earlier through ‘ill-health’ or ‘early retirement’. As a pensioner member you may have retired from work: continued to be employed by your employer but have begun taking some or all of your pension benefit: or begun taking your pension from a previous employer whilst working with another.

There is a degree of risk in all aspects of life and everything we do, and this is especially true of your pension benefits. There is no such thing as ‘no risk’ and no such thing as an absolute guarantee.

It is essential that you understand the main issues associated with security and risk as they affect YOU and your dependants, and your retirement benefits. This Factsheet is designed to make you think about the various issues associated with security and risk, WHY these occur and HOW these could have a bearing upon your pension benefits.

It is primarily written for pensioner members whose benefits are paid for out of the schemes assets (rather than those whose pension benefits have been secured by the scheme buying your pension with an insurance company). Different considerations apply where your pension has been bought out with an insurance company.

Some of the points are more obvious than others, but they are all important.

If you are intending to get advice from a Financial Adviser these are some of the things you should be discussing with them.

Security of your employment (risk of tenure)

If you continue to be working for your employer but have begun taking some or all of your pension benefit, the security of your employment may still play a part in your overall retirement planning.

The concept of a ‘job for life’ seems to be an unrealistic ideal. Businesses are constantly changing and most employment sectors, from manufacturing to finance, retail to transport have suffered large scale redundancies. Even with the same employer, change is now the norm and unless we as individuals are able to respond to these changes, we can be adversely affected by change.

Job security has an important impact upon your retirement provision if you still need the extra earnings.

Since 6th April 2006, employers have been able to offer flexible retirement which allows you to draw benefits and stay in employment, although this has still to catch on with many employers who have yet to decide whether they will offer this to scheme members. Furthermore, with Age Discrimination legislation having been introduced during 2006, employers are also having to look at both employment and pension practises and processes to avoid discrimination.

Many employers have or are in the process of raising the retirement age for employees to age 65, at which point many are choosing to make retirement from work compulsory.

Your pension benefit would have depended upon the length of your pensionable service – (which may have been counted in the number of years months or days) that you were credited with, whilst you were a fully active member of the scheme. If you are taking part of your pension benefit and continuing to work for your employer, you may have the option to continue to build up further pensionable service and so job security is important in working out your final benefits.

Security of the scheme’s sponsoring employer (covenant risk)

Even though you are receiving your pension benefit, it is important that you understand that your benefits rely on the solvency of the pension scheme and the sponsoring employer. However, your risk may be less than that of an active or preserved member, as for pensioner members (only those who have reached the scheme’s Normal Retirement Age though) your current level of pension is the highest priority if the employer or scheme fails.

It is important that your scheme’s sponsoring employer can afford to pay its contribution to the cost of benefits. This commitment can continue many last years after you have retired, to ensure all benefits are paid to all members and their dependents.

Most employers will be involved in redundancy programs. These can happen for a number of reasons. It may be part of a profit-driven exercise. A redundancy program might also be part of a steady downsizing of the business because of trading difficulties. Where the employer only pays the minimum redundancy payment, this could be an indication about the company’s deteriorating financial situation and its continuing ability to support the pension scheme. For more information, see our Quicknote The effect on the employer covenant.

Even though you have started to take your pension benefits, you still need to keep aware (as much as you realistically can) of the employer’s financial circumstances.

If you are a member of a Public Sector scheme (NHS, Local Government, Teachers, Civil Service etc.), your pension is funded by your contributions (if the scheme demanded that you pay contributions) and taxpayers, so ‘covenant risk’ is not as big an issue as it is for private sector scheme members.

Increasing life expectancy (mortality risk)

We’re living longer – and that’s a fact. But it’s not all good news. Longer life expectancy for pensioners leads to greater costs for employers and current active members as:

Pension schemes are facing paying pensions out for much longer than they had originally planned.

Employers are being asked to pay extra contributions to fund these additional costs.

The longer this trend continues, the more expensive pensions will become in terms of providing the actual pension income at retirement. The implications of living longer are something employers, schemes, members, government and society must all face up to.

Greater life expectancy will also mean an increase in State Pension Age which has historically been 65 for males and 60 for females. From 6th April 2010 (and over a 10-year period), State Pension Age for women will gradually increase to age 65:

Women born before 6th April 1950 are not affected by the change.

Women born between 6th April 1950 and 5th April 1955 will have a State Pension Age which gradually rises from 60 to 65 (see Table of State Pension Age).

Women born after 5th April 1955 now have a State Pension Age of 65.

So, from 6th April 2020 both men and women will have a State Pension Age of 65.

Under the Pensions Act 2007, the State Pension Age for men and women is to rise gradually over a period of 22 years between 2024 and 2046:

The first rise from 65 to 66 will be phased in between 2024 and 2026,

The second rise from 66 to 67 will be phased in between 2034 and 2036, and

The third rise from 67 to 68 will be phased in between 2044 and 2046

From 6th April 2046 both men and women will have a State Pension Age of 68.

The risk of current and future burdensome legislation and regulation will have an effect on your total pension provision even though are a pensioner member. State Pensions will increase for many in the future but for others, particularly higher earners, they will reduce.

The increased costs and liabilities to schemes, sponsoring employers (and taxpayers) of this swathe of legislation and regulation - particularly over the last 20 years – has had some unintentionally negative effects including:

The closing of significant numbers of pension schemes to new members.

The winding up of thousands of occupational pension schemes.

The ‘levelling down’ of member benefits to prevent discrimination (where one member is discriminated against another - it is less costly to ‘level down’ to the weakest factor rather than ‘level up’ to the strongest factor).

The irony is that most legislation was intended to improve and protect scheme members’ benefits. This in practice means higher costs for both employees and employers. The impact of these changes has led to thousands of schemes closing or winding up – hardly what was intended.

The creation of The Pensions Regulator was welcomed in many quarters but the levies it imposes on occupational pension schemes are viewed by many as excessive and unfair. This presents still greater costs for employers and further reason for them to review the costs and risks associated with providing a defined benefit scheme.

Political change also includes the risk associated with a change in Government as political parties have different agendas and priorities. Pensions and security in retirement continue to be a political ‘hot potato’.

Means-testing to provide a minimum overall pension for everyone after State Pension Age affects a growing number of pensioners, but the Pension Bill’s proposals seek to reduce this reliance on State top-ups of pensions.

Inflation and interest rates (economic risk)

Inflation and interest rates play an important role and therefore there is a risk element involved with them both.

Low inflation and interest rates have increased the value of the pensions payable to members and tended to make schemes less well funded which reduces member security.

High inflation and interest rates will tend to have the opposite effect as the spending power of your pension during retirement reduces.

Most private sector pension schemes have a ‘cap’ on the pension increases they pay to pensioners so over the longer term, high inflation would erode the value of your pension. High interest rates reduce the value of members’ benefits but the security to the benefit itself should improve. However, in such situations in the past, politicians have intervened to make schemes provide better inflation protection on benefits.

Market and exchange rates (investment risk)

The security of your pension benefits will rely on market conditions. Private sector pension schemes (and some Public Sector schemes) invest in a wide variety of assets with more schemes investing significant amounts on money in overseas markets. Pension benefits are paid from the employee and employer contributions and the investment returns on these assets.

The higher the return on the assets, the better the security for members. The value of assets will go up and down with the confidence investors have in the world investment markets. Consequently, the security of your full pension is influenced by market sentiment and linked to exchange rates if some of your schemes assets are traded outside the United Kingdom.

In terms of your scheme’s solvency, the skill of the investment manager in dealing with the state of the economy and markets is important. A weak economy or stock market can lead to greater deficits. A strong economy and buoyant investment returns can reduce deficits and increase surpluses. The investment manager can add value in any situation but can only buck the market trends by taking bigger risks.

If the value of the assets exceeds the value of the pensions due to members, the scheme has a surplus which means that contributions can be reduced or benefits increased. If, however, the value of pensions are greater than the value of its assets the scheme is said to be in deficit. The majority of pension schemes are currently in deficit.

Bought out Pensions (default risk)

For any scheme members whose pension benefits have been secured with an insurance company, financial risk is much less of an issue (if at all), as a policy will have been bought by your scheme to pay for your benefits. The insurance company carries all of the risks described above.

The benefits which the insurance company takes over are, in most situations, secure.

If your company goes into receivership and is then liquidated, it is possible that part of your pension can be sold back to the trustees and the proceeds of the sale used to help other members who have yet to retire.

Personal circumstances, age, health, income, assets (personal risk)

Your personal circumstances play an important part in your retirement planning:

Age: Your age is important. The older you are, the more secure you are likely to want your pension benefits to be.

Health: If you are in good health you will probably be more active during your retirement and therefore require more money to support your lifestyle. If you are in poor health, you may need to pay for carers. Your health situation is therefore very important.

Income and assets: The greater your income and assets, the less your reliance will be on means tested State benefits. The lower your income and assets, the more likely you will be to need additional State assistance.

Dependants: If you have financial dependants (e.g. spouse, civil partner, children) your spendable income will most likely be reduced compared with a single person without dependants on the same income.

These factors are important in a more subtle way. As a pensioner member, you may be less likely to be able to find suitable work to supplement your retirement income.

Your attitude to risk (financial risk)

In dealing with your any of your financial arrangements, you should consider your attitude to security, risk and reward. Each of them should be classed as a separate item (e.g. pensions, investments). Apart from any State Pension or Social Security benefits, your pension may now be your only income.

If you seek financial advice you should be asked what your attitude is to security, risk and reward. Pension and Financial Advisers will usually have standard forms to gather information about you, so that they may advise you according to your personal circumstances.

It is important therefore, that you make certain when discussing your attitude to risk, that you are specific about what this relates to. Your attitude to risk will probably differ when focusing upon your pension provision compared to your risk profile when investing in different assets (e.g. stocks and shares, property). Make sure that the attitude to risk used in any advice process, relates to your retirement provision and planning.

You may be asked to select your ‘risk profile’ from a list. An example would be a scale of 1 to 5, 1 to 10 etc. or choosing a sentence such as “My attitude to risk is conservative” or “My attitude to risk is balanced/medium”. When selecting a risk profile from a scale of 1–10 for example, make sure you know which is the low-risk end of the scale – obvious maybe – but important nevertheless.

Be sure to select the one that best fits you – not one you think will impress the adviser. If what you are presented with does not adequately reflect YOU – discuss this with the adviser – and make sure this is noted accordingly.

Your attitude to risk will probably have changed since you began to take your pension benefits as you seek to protect the benefits you have built up.

Summary and Key Points

When making enquiries about your pension benefit it is very important that you make it clear that you are a pensioner member rather than a preserved member or an active member. Active, preserved and pensioner are different classes of membership of a pension scheme and any definitions and paragraphs contained within your Scheme Rules or scheme literature relating to any benefit may differ considerably between these categories.

Risk comes in many forms – you should consider what risks YOU face in terms of your retirement provision.

Is your pension scheme secure?

Do you keep abreast of changes – legislation and regulation may affect your pension benefits?

Are you affected by the increase in State Pension Age?

Have you considered how your personal circumstances may impact upon your pension benefits?